Interest Rate Swaps and Rural Loans

December 18, 2013

You may have heard in the news that several banks are facing Commerce Commission action over loans made to farmers. The issue is the inclusion of “interest rate swap” contracts sold to the borrowers, ostensibly to lower their cost of borrowing, which subsequently turned out to cost significantly more than was forecast.

Interest rate swaps are complex transactions and belong to the family of “derivative” products, in which the value of the product can vary significantly, and often by far more than the original cost, when the underlying interest rates and exchange rates move. They are a handy tool for large organisations which use them to offset their interest rate exposure in different currencies and over differing terms. However, like all derivative products, they are also used by speculators to take large gambles on movements in interest rates and foreign exchange rates.

It is very questionable whether such contracts are appropriate for small, retail borrowers, and that is the crux of the Commerce Commission investigation. As with any complex and risky financial product, it is extremely important to get informed advice before buying. Commentators have pointed out that the farmers, some of their their accountants, and even some of the bankers offering the interest rate swaps lacked the understanding to give the farmers properly informed advice.

At Doyles, we are fortunate to have Andrew Ivory as one of our partners in our Lower Hutt practice, Doyle, Adams & Brook Ltd. In Andrew’s previous career he worked for many years as a derivatives professional, involved in the structuring, pricing, trading and risk management of interest rate swaps, interest rate options, and equity derivative products both in New Zealand and in the UK. Andrew is available to discuss any concerns you have with loan contracts you currently own, or with products you are considering.

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